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A five-day rally proved too much for the Dow Jones FXCM Dollar Index (ticker = USDolllar). Though risk trends were making little progress this past session (bullish or bearish) and the Fed announced that it would not be increasing its MBS purchases as some stimulus-addicts had expected, the dollar put in for a sharp decline Wednesday. Looking at individual performances, we find a better sense of why the dollar slid and why its immediate ambitions are not necessarily to see EURUSD surge above 1.3000. The Dollar Index is comprised of an equal weighting of four of the currency’s most liquid and fundamental distinct counterparts. For the benchmark EURUSD, the greenback actually put in for a modest gain on the day. Elsewhere, the reflection was on cross currency strength rather than dollar weakness. AUDUSD posted an aggressive rally largely due to the strong CPI figures while the cable rallied as a consensus for a rebound in 3Q GDP takes hold of speculative appetites.

For the dollar itself, the top fundamental concern remains general risk trends. In a market where rates are already extremely low, the near-zero yield on US benchmark rates lays the burden for sentiment on the volatility (i.e. ‘Risk’) side of the equation. On that side, we find that that the Forex-based FX VIX Index is very slow to pick up off its five-year lows while the equities version has actually eased back modestly from its three-month high (just below 20 percent). There are two means for leveraging the fear that catalyzes these measures higher: a severe deterioration on fundamentals or rapid price action away from higher yielding assets (which itself is often a response to the first factor).

This past session, we were met with a potential risk booster (and thereby dollar weight) in the form of the FOMC rate decision. Though the central bank had just introduced its QE3 program to buy $40 billion in mortgage-backed securities in September, there was a building murmur amongst the speculative ranks that the central bank would announce an increase to the size of the purchases in response to a pickup in benchmark rates or as a preemptive offset to the expiration of the Treasury purchases in the Operation Twist program at the end of the year. Recognition that the Fed wouldn’t ramp up stimulus removed a burden, but it wasn’t a spark for serious risk aversion. The same reticence heading into event risk and tepid reaction afterwards is a serious possibility heading into the end of this week with the US 3Q GDP reading.

On the topic of growth readings, the UK is scheduled to report its own third quarter GDP reading at (08:30 GMT). As we have seen many times before, the UK data has limited influence over the pound itself and rarely is the source of a meaningful trend from the currency. However, this particular piece of event risk carries more sway than most events. Furthermore, there are certain pairs that a particular outcome can play to serious breakout potential (like GBPUSD’s long-term trendline at 128.50) or spur a trend already underway (such as the GBPAUD decline or tentative EURGBP drop back below 0.8100). Key here is a significant enough surprise to stir momentum. The bar has been set high with the Bloomberg consensus showing a 0.6 percent quarterly jump. Falling short of elevated expectations in a weak risk environment would be painful.

Hope and speculation was starting to leak into the euro’s defense Tuesday with suggestions (initially by unconfirmed sources and then officials themselves) that said Greece had received approval for a two-year extension on its effort to return to the 3 percent deficit-to-GDP effort by the Troika. That was cleared up this past session when the German Finance Minister stated plainly that no such accommodations were made. Adding to that crush of unsubstantiated hope, the Euro Zone PMI Composite ( a good, timely proxy for general growth) printed at its lowest level since June 2009 and rumors began to circulate that EU officials were demanding junior bond holders of Bankia take losses. Quite the change.

The kiwi was easily the biggest mover on the day Wednesday. Once again, market expectations set up a big move from what would have otherwise been considered a ‘neutral’ outcome for event risk. After New Zealand 3Q inflation dropped to its lowest level since 1999 (a 0.8 percent reading that was well below the target band), the market started to assume, the RBNZ would take the same tack as the RBA in a dovish tone. Instead, new Governor Wheeler retained a slight hawkish bias. This is good for a relief rally on risk pairs and momentum for AUDNZD.

As the market’s favorite funding currency in the carry trade, we have come to expect the Japanese yen to hold a perfectly negative correlation to risk trends (fall when sentiment improves, rise when confidence collapses). However, recently we have seen a significant turn on benchmarks in the US equity indexes; and yet, the commodity currency pairs have not conceded to the push. The yen is a safe haven currency in many regards, but there is a better alternative (USD). Carry is what sustains the correlation, but how much carry exposure is left in the market. In the meantime, there is now a suggestion floating around that the government will announce a 400 billion yen stimulus program on Friday.

The Aussie dollar started a rally early Wednesday morning that began with the surprise showing from 3Q CPI figures. The 2.0 percent pace is hardly turning doves to hawks, but it does remove some pressure for aggressive cuts. Then there was the Chinese PMI figures which printed better than expected but were 12 months into a contractionary phase. In fundamentals terms, this is a relief rally. To continue, risk is important.

Gold Tests 1700 as Fed Holds Back on Stimulus

Though there was considerable back and forth for FX pairs this past session, gold aligned nicely to the fundamentals. A reflection of an otherwise steady dollar, the precious metal would look at the Fed decision for guidance. An increase in MBS purchases would have dinged the value of traditional currency nicely and bolstered the alternative store of wealth’s appeal. Alas, that didn’t happen. Traders watch 1700.

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